Insight from a Master

When John Hathaway spoke at the Casey’s Gold and Resource Summit
in October, many of the audience came away feeling like they were
listening to Doug Casey, with his contrarian views, bold statements,
and laying much of the blame for our current problems at the feet of
government. Read what John, a seasoned investment pro and manager of the
famously successful $1.4 billion Tocqueville Gold Fund, has to say
about gold, precious metals stocks, and the future of the U.S. dollar.

John Hathaway: We launched the Tocqueville Gold Fund
(TGLDX) in 1998 when it was a very contrarian idea. I always like to
say it was the "Rodney Dangerfield" of investments at the time because a
lot of people laughed at us and we didn’t get much respect. It was
essentially a very contrarian investment theme, and we did it at a time
when the markets were going nuts for dot-com stocks, which we thought
was absolute lunacy.

Our thesis is basically related to the lack of faith that
institutions, investors, and citizens have in paper money. That shift
in opinion has come in fits and starts but is the core reason gold has
risen to the extent it has. And until you have a significant
restoration in terms of confidence in paper money, gold should do very
well.

Jeff: Some are calling gold a bubble.

John: Many people – I'd say most people – are not on
board. So to me it's not a bubble. Maybe it's on its way to being a
bubble, but a bubble has to be pervasive and ubiquitous and in every
fiber of every investment institution and every investor portfolio, as
was dot-com and housing, and we simply have not reached that stage. The
best line I've heard is, "A lot of people have had a first date with
gold, but they still haven’t gotten to first base."

Jeff: [Laughs] That's good.

John: The fact is, people talk about it because it's
newsworthy. The price is rising and making news, but so what? That
doesn't make it a bubble. My thesis is that everyone should make a
strategic allocation to gold because it's the counterweight to paper
money that continues to lose credibility as a store of value.

Jeff: So the U.S. dollar is going a lot lower, in your view?

John: Yes. You're beginning to see a lot of bilateral
trade deals between China and Latin American countries that have to be
settled in renminbi. You're seeing similar moves on the part of other
trading partners completely bypassing the dollar in international
trade. You're seeing growing currency controls, particularly for
capital flows – Brazil and Thailand are two countries that come to
mind. At this point it's not chaotic, but these are precursors to what
could become chaotic. It seems orderly right now, but it could become
more accelerated.

I'm also very skeptical that QE2 is going to do any good. And if the
economy is still stagnant a year from now, there's going to be QE3,
QE4, and QE5. I just don’t see how anyone can not have some gold in
this environment.

Jeff: We think inflation ultimately wins the battle over deflation. Do you agree?

John: For the most part, yes, but I don’t think you
have to know which we'll get to decide if you should buy gold. If we
have a deflationary morass, where we're stuck in a liquidity trap for
the next five years, it will make the government do all kinds of crazy
things that will undermine the value of money, which will ultimately
turn out to be inflationary. This debate between deflation and
inflation is always interesting, but I don’t think it matters if you're
invested in gold. I think in either outcome, gold wins.

Jeff: Are you as bullish on silver?

John: When you're talking about monetary issues,
silver will certainly benefit, particularly in an inflationary
sequence. On the other hand, if we have a deflationary sell-off like we
had in 2008, silver is going to underperform. So with silver I think
you have to be more certain about the outcome. Silver is more dependent
on inflation to do well. That's because silver has industrial uses,
which would disappear or be greatly undercut in a deflation.

Jeff: What about the other precious metals, platinum and palladium?

John: Frankly, they’re not a big part of the portfolio right now. But we would consider them if we found good investment vehicles.

Jeff: Speaking of sell-offs, what odds do you put on us having another one like in 2008?

John: The potential is there. I don’t know where it
would come from, but one possibility would be another sovereign debt
issue in Europe. Another possibility is if the bond market had a
serious setback and triggered a run to liquidity, although there aren’t
that many places to go anymore. Turmoil in the currency markets is
certainly a concern to policymakers. All of those things could bring
about another worldwide margin call like we had in 2008.

Jeff: So should we avoid gold stocks right now due to the risks?

John: It depends on your risk profile. If you're
conservative and don’t want to lose any sleep, I think you hold physical
gold as a hedge against the rest of your portfolio. But if you're more
of a risk-taker and see the macro-landscape as an opportunity, even
though it's a negative view, you definitely want to have exposure to
gold stocks. And if they’re good companies, they should outperform the
gold price because they’re generating a lot of earnings and cash flow
at these prices. Then there's M&A [Merger and Acquisition]
activity, growth potential, and also dividends. So there are a lot of
things that a gold stock can provide that a physical metal cannot, but
it depends on the risk profile of the specific investor.

Jeff: It's interesting you bring up dividends, because gold
and silver miners don't pay very high dividends. Do you think that
could change given the high margins the industry is seeing?

John: Good point. The returns on capital as an
industry have gone to very good levels, and if they’re sustained, which
obviously depends on the gold price continuing to do well, they’re
going to have too much cash to reinvest in the business. And the
smarter companies will realize they have an opportunity to become core
yield stocks that have the same panache as, say, Microsoft, IBM, Exxon
Mobil, etc. If they play their cards right, they could become core
holdings of bank trust departments and open the door to an entirely new
audience of investors. That's how you'll get good valuations in the
gold stocks.

Jeff: Which brings up the possibility that maybe we won't
eventually sell all our gold stocks, if they start paying high
dividends…

John: Right. If the macroclimate is favorable for
gold and we don’t blow up into a crisis where it's the end of the
world, but instead get a steady state of rising prices, then gold
stocks could take on a completely different identity. They’re viewed
now as mostly fringe investments, but there was a time, back in the
'60s and '70s, when they were viewed as pretty standard stuff for an
investment portfolio.

Jeff: How do you go about evaluating a mining stock?

John: We have a group of analysts here in New York
who meet with management teams all year round. There isn't a day that
goes by that we don’t have one, two, three, or more companies coming
to see us, and the reason is that the industry is generally capital
intensive and needs money. So we're sort of the go-to "piggy bank."

In addition to that, our guys know rocks and travel far and wide to
look at mine sites all over the world. I think we've logged over half a
million miles in the last five years going to god-awful places – this
is not a Club Med itinerary. So we're able to develop conviction about
owning some of these earlier-stage junior mining companies that aren't
on the radar screen of our competitors. In fact, our average market cap
in the Tocqueville Gold Fund is 60% of our peer group, which would
indicate a weighting towards earlier-stage companies.

Jeff: So the fund invests quite a bit in juniors.

John: Absolutely. We have to be careful with it, of
course, because they're less liquid and riskier, but the fact that we
have this sort of database of information from these meetings gives us a
fair amount of success in terms of picking the good ones. Obviously
there are plenty we've missed that are good, and there are plenty we've
invested in that turned out not to be so great, so it's always a bit
of a trial-and-error thing. But we have found that when we buy into a
company at an early stage that meets its milestones and advances from A
to B and then from B to C, they’ll need more money and we'll continue
to finance them along the way. That is the single biggest source of our
success.

Our turnover rate is very low – less than 10% – so we basically take a
long-term investment view on what we think are the very best emerging
mining companies. An example would be Osisko (T.OSK), which we started
financing five or six years ago when it was a 50-cent junior, and now
it's a $14 company, which will be producing gold within a year. That's
the ideal progression we like to find.

Jeff: Any companies that look particularly undervalued to you right now?

John: We have a big position in International Tower
Hill Mines (THM/T.ITH), which we feel is on the cusp of becoming
recognized as one of the next big major mines in North America. I would
put Osisko in the same sentence, though it's obviously much further
along than ITH. I wouldn't necessarily run out and buy these today, but
those are big holdings for us and have done very well.

Jeff:Any closing comments for gold investors?

John: Gold may go sideways for a while, which is my
wish, but who knows what's going to happen? Things could blow up, so
trying to trade in and out is a huge mistake, in my opinion. To me, the
most intelligent view of gold has to be from a strategic point of
view. Get over the fact that it's gone up a lot, then try to be as
clever as you can about legging into it. The bottom line is, you've got
to own gold in this environment.

Jeff: Good advice, John. Thanks for your time.

John: You're welcome.

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[John Hathaway is only one of many fund managers who are betting on
gold and major gold stocks now, and the investing crowd is starting to
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